Public Employee Benefits: The Numbers Behind the Debate

Setting aside the politically sensitive aspects of the ongoing national debate over public workers' benefits, we can learn a lot from a fundamental economic analysis of one city's pension and health care costs.

Before we get to that specific analysis, more broadly, growth in the overall economy as measured by GDP is the basis for higher incomes and higher taxes. If GDP is flat, then household incomes are also flat. If the government increases taxes by more than the growth rate of the GDP, it's virtually certain to crimp household disposable income.

Below is a graph of U.S GDP growth since 2000. Adjusted for inflation, the U.S. economy grew smartly between 2001 and 2007 -- 35% -- and then went flat. In constant dollars, U.S. GDP in 2010 was almost precisely the same as it was in 2007: $13.363 trillion in 2007 and $13.382 trillion in 2010.

But household income hasn't even been treading water -- it has declined. According to the Census Bureau, real median household income in 2009 was $49,777, a 5% decline from its 1999 peak of $52,388 (adjusted for inflation).

To keep the U.S. economy afloat, the federal government has borrowed and spent extraordinary sums of money. As I recently reported on DailyFinance, federal spending has leaped by about $1 trillion since 2007. The national deficits of the past three years and the estimated shortfalls for fiscal years 2011 and 2012 exceed $6 trillion.

2008: $458 billion
$1.4 trillion
2010: $1.3 trillion
2011: $1.5 trillion (CBO est.)
2012: $1.6 trillion (est.)

But without this infusion of federal spending, U.S. GDP would have declined, as indicated by the red line on the chart.

Clearly, the macroeconomic backdrop hasn't been conducive to higher wages or increased tax revenues.

States and Local Government Face Structural Shortfalls

Combine a flat economy and declining household incomes with state and local government costs that keep rising, and the result is a structural disconnect between revenues and expenses. The nonpartisan Little Hoover Commission closely examined the finances and governance of public pensions in California, and it recently issued a 100-page report on this long-term structural disconnect between expected pension revenues and state revenues, and pension expenses.

So, let's take a closer look at Berkeley, Calif., home of the University of California at Berkeley, as a typical representative of other "town-gown" college cities in the U.S. (For context: Berkeley's population is about 102,000, while Madison, Wis., has about 235,000 residents.)

While these numbers may be higher than your local city, county and state figures, they track national trends in public pension and health care costs.

In Berkeley, pensions for retired city workers will cost about $32.7 million in fiscal year 2013 and rise to $41 million by 2016. Those figures are up from about $2 million in 2000.

Clearly, pension costs are rising significantly faster than GDP. Even if we assume the $2 million pension costs in 2000 were significantly under what should have been contributed and push that starting point up to $10 million (the light-blue line), the trend doesn't really change: Pension costs are still rising steeply while GDP is either flat (including unprecedented federal borrowing and spending) or declining (if we factor out the massive federal spending).

Public employee health care costs have been rising an average of 11% per year in the decade since 2000.

Here's what happens to $1 in health care spending when costs increase 11% per year:

$1 (2001)
2.08 (2008)
$3.15 (2012)
$4.78 (2016)

At this rate of growth, costs triple by 2012 and almost quintuple by 2016, which illustrates the fundamental problem: Revenues are flat due to a slow economy, while costs are rising at a rate far exceeding that of the general economy.

Willie Brown, a staunch union supporter and former California legislative leader and San Francisco mayor, recently wrote in the San Francisco Chronicle:
People constantly ask how we wound up in this mess. The answer is, we are all to blame. There was no way we [political leaders] should have agreed to guaranteed fixed-amount pensions and health care packages without takebacks that would have triggered if the economy went bad. And the public also needs to shoulder some of the blame for voting repeatedly to expand retirement benefits, especially health benefits for government workers and their families, which are turning out to be an even more expensive problem than pensions.
The other backdrop to today's benefit crisis relates to the relative performances of the stock market during two key periods. In the later half of the 1990s, the markets outperformed, and many pension and benefit plans modified their contribution regimens based on projected annual stock market growth rates of 8% -- forever. But the market has underperformed since the 2000 peak, and after a decade of those weak returns, it's no surprise that pension funds are facing shortfalls.

Adjusted for inflation, stock returns since 2000 have been negative, even counting dividends. The S&P 500 index has declined from over 1,500 in 2000 to around 1,300 in 2011 -- a 13% decline that must be added to a reduction in purchasing power (inflation) of another 28%. Not counting dividends of around 2% a year, that's a decline of 41%. Just to stay even with inflation, the S&P 500 would have to be above 1,900 now.

A 2% annual dividend yield compounded since 2000 turns $100 into $124.34. So buy-and-hold pension funds have experienced a 24% gain based on dividends since 2000, but a 41% loss in equity value, resulting in a net 17% loss. A 2% (inflation-adjusted) growth rate in the real economy compounds to a 24% increase over 11 years -- but that 11% annual increase in employee health care costs discussed earlier compounds into a 315% increase.

And there, where those two macroeconomic forces collide, lies the heart of the debate over public workers' benefits: Not in "greedy" unions or "heartless" union-busters, but in the stock market's underperformance (plus some absurdly optimistic planning assumptions) and the rapid growth of health care costs.

If we as a nation can't trim the growth rate of health care costs to match the growth rate of the economy, we'll face a structural financial problem that won't go away.

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It was OK to bail out big Wall St. firms & banks, and GM, at taxpayer expense

so whats so absurd about bailing out troubled states? Personally I think it

makes more sense than bailing private businesses that " Were to big to fail"

March 03 2011 at 2:07 PM Report abuse -1 rate up rate down Reply

The fix is simple. Remember Fed bailing out Wall St & Big Banks? Did I hear TARP?

Now is the time for FED to bail out the near bankrupt states and their

underfunded pensions and healthcare programs. As states can't print $$(a good

thing) Uncle Sam to the rescue.

But that would be bailing out the taxpayers in those mismanaged states, So it

will never happen.I guess no state is to big to fail.

March 03 2011 at 12:44 PM Report abuse -1 rate up rate down Reply
1 reply to vetmanl's comment

So steal money from citizens of all states to give to some state governments who could have stolen money from their own citizens? The problem isn't stealing more from any citizens. It's that the costs are skyrocketing beyond the ability of taxpayers to absorb.

March 03 2011 at 12:51 PM Report abuse +2 rate up rate down Reply

On the backs of working class folks, tax cut for the rich ?? great idea GOP, nice job Brownie LMAO

March 03 2011 at 11:29 AM Report abuse -3 rate up rate down Reply

If the economy is comming back like they say then we dont need Obamacare nor do we have a need to end collective bargaining inflation is the cure all. Rhetoric and media propaganda is bad for reality. what can we believe ?

March 03 2011 at 11:12 AM Report abuse +1 rate up rate down Reply

The loons seem to be having a difficult time mounting a defense.

March 03 2011 at 11:08 AM Report abuse +2 rate up rate down Reply

Excellent fact based article. For a change it has no opinion based on idealogy as most "journalists' do on here. If people stuck to facts like this, perhaps we could find solutions. (I know I am dreaming)

March 03 2011 at 11:07 AM Report abuse +5 rate up rate down Reply

"The economy grew smartly between 2001 and 2007"... Are you kidding me? You have discredited yourself for the rest of the article based on that statement.

March 03 2011 at 9:21 AM Report abuse rate up rate down Reply
3 replies to andy's comment

Another pretty good article by Smith. Although I tire of the incorrect assumption that absent all the additional government spending, GDP growth would have been less. Every dime the govenment spends is a dime that was raised from the private sector via either taxation or spending. As such, all that money would have been spent or invested anyhow. Perhaps the simultaneous increase in government spending, accompanied by a decrease in economic growth isn't such a coincidence. Beyond this mistake, the article hits the nail(s) on the head. Now all we have to do is acquire a basic understanding of economics. Will the price of something (like health care insurance, for example) go up or down if we forcibly dedicate more resources to its consumption?

March 03 2011 at 9:03 AM Report abuse +1 rate up rate down Reply

We're going to have to deal with these problems. We can't continue to run this communism for much longer. I, for one, am TIRED of working to support other people's families. I work hard every day to earn a living. My tax dollars are used to GIVE money, housing, food stamps, medical care, etc. to people who don't work. I'm not complaining whatsoever about helping the widows, the elderly who are unable to work for themselves and orphans. It's the ones I see who are able to do for themselves who I resent. In a true communism, it's share and share alike. Share the work, share the food, share the community facilities. Our country is actually set up WORSE than communism. Less than 50% of the working age population works to support themselves AND the others who DON'T work! For you out there sponging off of me and the rest of society that does work: Get up off the couch and grab a shovel, grab a spatula, grab a broom, just GO TO WORK. I'M TIRED OF CARRYING YOUR 400 POUND, WELFARE, FOOD STAMP DRAWING LARD BUTT. If things don't improve soon, I will have to announce my candidacy for President. I don't think I can stand to watch this crap much longer. Our elected public servants are looking out for themselves ONLY. We're living in an era where a "cushy job" is prized? What happened to pride in working hard and doing a good job? Why is it always about "increased profits"? Since when is a big corporation not satisfied making Billions of dollars a year? Why is everyone pumping their money into the stock market? Don't they realize that to use the money for retirement, they'll have to sell their stocks? What happens when more people sell a stock than buy a stock? (The price goes down, Einstein.) Somebody better do something and do it quickly, we're gonna' go to hades in a hand basket! (Unlike the song says "We're NOT going to enjoy the ride."

March 03 2011 at 12:04 AM Report abuse +3 rate up rate down Reply

You may seen movies that along with t.v. news, that in the past have given coverage of the downside to unions. BUT I am aware of the facts as history has born witness. Like, how we've come to get paid vacations, geif pay, personal days off, and not being held responsible personally for damaged goods, to some extent as offshutes of the presecense of organized labor. I recall movies based on the reality of non-union sweatshops of the early 20th century, and how it took deaths before companies of that era finally reconized that these were not good for our countrys prosperity. While I'm NOT currently a union member, I am a relative of a couple, who contributing members of society. Please lets not throw the baby out with the proverbial bathwater. That is what I have to say about collective bargaining. It's my personal opinion. Speaking FOR MYSELF.

March 02 2011 at 8:05 PM Report abuse -1 rate up rate down Reply